S&P Ratings Suit, CBOE-SEC Talks, Bonuses: Compliance

Feb. 11 (Bloomberg) -- The Justice Department decision to
sue Standard & Poor’s has investors asking why Moody’s Investors
Service and Fitch Ratings weren’t targeted for awarding the same
top grades to troubled mortgage bonds and other debt securities.

The Financial Crisis Inquiry Commission and a Senate panel
laid the blame on S&P, Moody’s and Fitch for inflated ratings on
mortgage-backed securities and collateralized debt obligations
that helped cause the worst financial crisis since the Great
Depression. Together, they provided 96 percent of all ratings
for governments and companies in the $42 trillion debt market in
2011.

The U.S., in a lawsuit filed Feb. 4 in federal court in Los
Angeles, is alleging that the unit of New York-based McGraw-Hill
Cos. defrauded investors by failing to adjust its analytical
models or taking necessary steps to accurately reflect the risks
of the securities because it was afraid of losing business.

The federal case was assigned to U.S. District Judge David
O. Carter in Santa Ana, California.

S&P lowered the U.S. government’s credit rating one step to
AA+ from the top AAA rank on Aug. 5, 2011, after months of
wrangling between President Barack Obama and Congressional
Republicans over whether to raise the federal debt limit. Bond
investors repudiated the downgrade and U.S. borrowing costs fell
to record lows as Treasuries gained the most since 2008.

S&P has used this as a defense. Floyd Abrams, the Cahill
Gordon & Reindel LLP lawyer representing the company, said in a
Feb. 5 appearance on Bloomberg Television that investors
required two ratings on CDOs before they would buy, yet only S&P
has been accused of acting in bad faith.

For more S&P suit coverage, see {EXT3 <GO>.}

S&P Case To Turn on Question of Fraud, Not First Amendment

Standard & Poor’s lawyers will have no shortage of legal
arguments as the ratings service defends a novel U.S. claim that
it defrauded investors by deliberately understating the risk of
mortgage-backed bonds.

U.S. success in the lawsuit in federal court in Los Angeles
is “far from clear,” said Jeffrey Manns, an associate
professor at George Washington University Law School. S&P’s
defense may include evidence that the agency believed in its
ratings and proof that U.S. fraud allegations are unfounded.
Company lawyers are also weighing whether to argue that the 1989
statute underpinning the case doesn’t apply to S&P.

“We start with proposition that we deny there was any
fraud,” Floyd Abrams, one of the lawyers for the ratings
service, said Feb. 7 in a phone interview. Fraud claims have “a
high burden of proof.”

In a Feb. 5 interview with Bloomberg Television, Abrams
said this is not a First Amendment case because “the government
is alleging that S&P didn’t believe what it said. The First
Amendment doesn’t protect against that.”

S&P rated more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of collateralized-debt
obligations from September 2004 to October 2007, the government
said.

The Justice Department accuses S&P in its complaint of
falsely representing to investors that its ratings were
objective, independent and uninfluenced by any conflicts of
interest. The company shaped its ratings to suit its business
needs by weakening adjustments to its analytical models and by
issuing inflated rankings on CDOs collectively worth hundreds of
billions of dollars, according to the complaint.

In the 128-page civil complaint, the U.S. cites internal e-mail exchanges to bolster its case, including one in which an
S&P analyst allegedly telling a colleague in April 2007 that
deals “could be structured by cows and we would rate it.”

The U.S. may seek more than $5 billion in damages, acting
U.S. Associate Attorney General Tony West said on Feb. 5.
McGraw-Hill, which had net income of $867 million in the past
four quarters, denies wrongdoing.

“The fact is that S&P’s ratings were based on the same
subprime mortgage data available to the rest of the market --
including U.S. government officials who in 2007 publicly stated
that problems in the subprime market appeared to be contained,”
Catherine Mathis, a company spokeswoman, said in an e-mailed
statement after the lawsuit was filed.

The case is U.S. v. McGraw-Hill, 13-00779, U.S. District
Court, Central District of California (Los Angeles).

For more, click here.

S&P May Face Suits by More States, Connecticut’s Jepsen Says

Standard & Poor’s may be sued by more states over credit
ratings on mortgage products, adding to state and federal
lawsuits filed against the company, Connecticut’s attorney
general said.

Connecticut Attorney General George Jepsen, who is leading
a multistate coalition, said some states are considering
lawsuits against the McGraw-Hill Cos. unit in addition to at
least 16 that have already sued.

“We know some states are actively considering it,” Jepsen
said Feb. 7 in a phone interview.

Connecticut, Mississippi and Illinois sued Standard &
Poor’s previously. Thirteen states and the District of Columbia
sued this week with the Justice Department, according to a
statement from Jepsen’s office. Connecticut also has a lawsuit
pending against Moody’s Investors Service.

Jepsen declined to comment on how many states are
considering lawsuits and whether officials are investigating
Moody’s and Fitch Ratings.

New York Attorney General Eric Schneiderman is
investigating whether S&P, Moody’s and Fitch violated a 2008
settlement that was reached with his predecessor Andrew Cuomo as
well as conduct by the companies since that agreement expired at
the end of 2011, according to a person familiar with the matter.

Massachusetts Attorney General Martha Coakley is also
investigating S&P, spokesman Brad Puffer said in an e-mail.

S&P Lawyer John Keker Brings Slash and Smash Tactics to Defense

San Francisco lawyer John Keker, the Vietnam War platoon
leader who later prosecuted Oliver North and represented clients
from Eldridge Cleaver to Lance Armstrong, may deploy his
“slashing and smashing” approach to defend Standard & Poor’s
Financial Services LLC.

Keker will work with the company’s New York law firm Cahill
Gordon & Reindel LLP and its partner Floyd Abrams. Keker, 69, a
founding partner of Keker & Van Nest LLP, was once voted by 100
of his California colleagues as the first lawyer they’d hire if
charged with a serious crime.

In a 2003 Bloomberg News profile, Keker said he honed his
“slashing and smashing” defense tactics in white-collar crime
trials and corporate litigation. He didn’t respond to an e-mailed request seeking comment on his hiring by S&P.

Lawyers from both firms will be in court for any trial,
Abrams said Feb. 7 in a phone interview. He said the precise
division of labor among the lawyers hasn’t been determined.

Cristina Arguedas, a criminal defense lawyer who has known
Keker since 1980, described Keker as someone who “lives to try
cases.”

For more, click here.

Compliance Policy

EU’s Karas Says Draft Deal on Basel Banking Law Reached

European Union lawmakers and representatives of member
states reached a preliminary compromise on the bloc’s new
banking rules, the lawmaker leading the talks said.

The draft deal was made during discussions last week
between legislators and Ireland, the current holder of the EU
presidency, Othmar Karas, vice president of the European
Parliament, said at a conference in Vienna today.

Compliance Action

CBOE in Settlement Talks Over SEC Probe, Sets Aside $5 Million

CBOE Holdings Inc. said it’s in settlement talks over a
U.S. Securities and Exchange Commission investigation and has
set aside $5 million to cover the resolution.

The biggest U.S. options market by volume said a year ago
that regulators were probing whether the company complied with
its obligations as a self-regulatory organization. American
exchanges are required to write rules for their markets, monitor
trading and seek to ensure that they and their customers aren’t
breaking securities laws.

“We’re engaged in ongoing settlement discussions with the
SEC staff on the resolution of this matter,” Chief Financial
Officer Alan Dean said on a conference call with analysts. “No
agreement has been reached.”

John Nester, a SEC spokesman declined to comment. Gail
Osten, a spokeswoman for CBOE, declined to provide more
information.

Interdealer Brokers Emerge as Key Enablers in Libor Scandal

Interdealer brokers, the middlemen who line up buyers and
sellers of securities for banks, are emerging as key enablers in
the Libor scandal after three firms paid a total of $2.6 billion
for rigging global interest rates.

Employees at firms including ICAP Plc, the world’s biggest
interdealer broker, and RP Martin Group Ltd., a smaller British
competitor, passed on requests from derivatives traders asking
rate-setters at others banks to make favorable submissions, e-mails released as part of the global probe of interest rate-rigging show. In some cases, the middlemen took bribes as
payment for the services in the form of so-called wash trades,
regulators said, without identifying the firms that did.

The brokers assumed greater influence as credit markets
froze at the start of the financial crisis in 2007. Bankers
charged with making submissions to the London interbank offered
rate increasingly relied on information from the brokers to
determine what figures to contribute.

Brokers were willing to help traders to win future work.
Some were also rewarded with so-called wash trades, where
counterparties place two or more matching trades through a
broker that cancel one another out while triggering a payment of
fees to the middle man, according to transcripts released by
regulators on Feb. 6.

Spokesmen for RP Martin and the FSA declined to comment.
involved with.

“I’m pleased that the FSA and other regulators are
investigating this thoroughly and rooting out any wrongdoing so
that the industry can, in time, heal and move on and learn from
it and be better for it,” Chief Executive Officer Michael
Spencer told reporters last week.

For more, click here.

Courts

Citigroup Argues for Approval of $285 Million SEC Settlement

Citigroup Inc. asked a U.S. appeals court to overrule a
trial judge and let its $285 million mortgage-securities
settlement with the Securities and Exchange Commission go
forward.

The bank is challenging U.S. District Judge Jed S. Rakoff’s
2011 refusal to approve the agreement, which would resolve
claims that New York-based Citigroup misled investors in a $1
billion financial product linked to risky mortgages. The SEC
claimed Citigroup cost investors more than $600 million.

Rakoff criticized the SEC practice of agreeing to
settlements that don’t require defendants to admit wrongdoing.
He said the parties didn’t give him “any proven or admitted
facts” he could use to determine whether the settlement was
fair.

Brad Karp, a lawyer for Citigroup, argued Feb. 8 to a
three-judge panel of the U.S. Court of Appeals in New York that
if companies are forced to admit wrongdoing as part of a
settlement, lawyers for shareholders will use the information to
sue in securities-fraud cases. The companies would be better off
not settling, he said.

SEC lawyer Michael Conley argued that courts should give
deference to the agency’s judgment that a particular settlement
is in the public interest.

John Wing, a lawyer appointed by the appeals court to
defend Rakoff’s ruling, agreed that Rakoff can’t require
Citigroup to admit liability as the price for approving the
settlement.

Wing said the parties didn’t give Rakoff sufficient facts
for him to determine whether the settlement was fair, adequate,
reasonable and in the public interest, as required by law. He
said Rakoff could require the parties to submit evidence from
depositions, documents or affidavits.

The case is U.S. Securities and Exchange Commission v.
Citigroup Global Markets Inc., 11-05227, U.S. Court of Appeals
for the Second Circuit (New York).

For more, click here.

SEC Says Chicago Man Lured Chinese Investors in Citizenship Scam

The U.S. Securities and Exchange Commission sued a Chicago
man over claims he fraudulently raised more than $145 million
primarily from Chinese investors by promising that their
investments would provide a pathway to U.S. citizenship.

Anshoo R. Sethi, 29, over the past 18 months duped more
than 250 investors into believing that backing his project to
build a hotel would give them access to the EB-5 Immigrant
Investor Pilot Program, the SEC said in a Feb. 6 complaint
unsealed Feb. 8 at U.S. District Court in Illinois. Certain
investors who create or preserve at least 10 jobs for U.S.
workers can get U.S. residency permits through the program.

A phone call to a number listed for Sethi wasn’t
immediately returned.

The Chicago Tribune reported last year that Illinois
Governor Pat Quinn’s administration originally supported Sethi’s
project. In January 2012, however, state officials demanded that
Sethi remove Quinn’s image and the state’s seal from materials
he used to solicit investors, the Tribune reported.

Interviews

Lew Will Have to ‘Wrestle’ With Dodd-Frank, Sachs Says

Lee Sachs, co-chief executive officer of Alliance Partners
and a former assistant U.S. Treasury secretary talked about
Timothy F. Geithner’s legacy as U.S. Treasury secretary and the
outlook for Jack Lew, President Barack Obama’s nominee to
succeed Geithner.

Banks Should Have Tougher Internal Auditors, FSA’s Bailey Says

Banks should have tougher internal auditors to stand up to
senior decision makers within the firm and oversee risk taking,
said Andrew Bailey, head of banking supervision at the Financial
Services Authority.

Regulators now expect banks to have internal auditors that
can provide a challenge to management, “driving improved
governance, risk management and internal controls,” Bailey said
in an e-mailed statement.

Bailey’s comments came in support of draft guidelines
published by the Chartered Institute of Internal Auditors that
seek to improve governance within banks.

Comings and Goings/Executive Pay

Banks Should Defer Bonuses for Up to 10 Years, Jenkins Says

Bankers’ bonuses should be deferred for as long as 10 years
to hold executives accountable for risks, said Robert Jenkins, a
member of a Bank of England committee charged with ensuring
financial stability.

“Five years might or might not be appropriate for some
categories of risk, but if we are going to rely on remuneration
as a key driver of financial stability then it should probably
be between five or ten years,” Jenkins said in an interview
Feb. 7 in Washington. “Ten years would capture the majority of
risk cycles and therefore the gains and losses that came from
any risk that was taken today.”

Jenkins’ comments echo those of Andrew Haldane, another
member of the BOE’s Financial Policy Committee, and signal U.K.
regulators may continue to push banks to reduce risks. The
central bank, which is adding regulatory powers to its monetary-policy remit, said in November banks may need to raise more
capital to cover loan losses and that they may have overstated
their capital strength.